c. Same answer as in part b. above.

pp. 7-4 to 7-6

2. a. Black, Inc. must report on its income tax return the greater of the depreciation allowed of $10,000 ($12,000 X 10/12) or allowable of $12,000. The depreciation allowed is the amount actually deducted, whereas the depreciation allowable is the amount that should have been deducted under the depreciation convention. Black should amend this year's tax return and deduct the correct amount of depreciation ($12,000).

Realized losses on personal use assets are not deductible.

b. Same result as in part (a) above.

p. 7-7

A realized gain on the condemnation of a personal use asset is recognized if similar property is not acquired.

c. If the house were income-producing property, the realized loss of $10,000 would be recognized.

pp. 7-6 and 7-7

5. Marmot & Squirrel should defer the realized gain on the disposition of the warehouse. Therefore, the partnership should structure the transaction to qualify as an involuntary conversion. Thus, the associated issues are whether the form of the disposition qualifies and whether the replacement qualifies. The acquisition by the condemning authority would qualify. Since the city is condemning the property, the sale to the real estate broker also would qualify. Replacing the warehouse with the office building will qualify since the form of the involuntary conversion is the condemnation of real property used in a trade or business. Unless the firm via the negotiation process can get more from the city than the real estate broker, it should sell the land to the real estate broker and replace it with the office building within the qualified replacement period (i.e., three years from the end of the tax year in which a proceeds inflow is received that is large enough to produce a gain). pp. 7-29 to 7-32

6. a. Finch, Inc.'s adjusted basis for Bluebird Corporation stock on December 31, 1998 is $210,000 ($150,000 + $60,000).

c. If Finch cannot adequately identify the shares sold, a FIFO presumption is made. Thus, the 60 shares sold are presumed to come from the 100 shares purchased on June 3, 1998 for $150,000 (i.e., $1,500 per share). Therefore, Finch has a recognized loss of $39,000 as calculated in (b) above.

pp. 7-8 and 7-9

7. a. Agne's realized and recognized gain on the sale of his business is calculated as follows:

b. Randy's basis for each of the assets is as follows:

The basis for each of the listed assets is the fair market value. Application of the residual method results in the balance of $115,000 ($900,000 - $785,000) being assigned to goodwill.

c. Willis, Davis, Raabe, Kaplan, and Engle, CPAs

50 Kellogg Boulevard

St. Paul, Minnesota 55164

June 1, 1998

Randy Morgan

300 Riverside Drive

Cincinnati, OH 45207

Dear Randy:

I am responding to your inquiry regarding your proposal to purchase the assets of Agnes's sole proprietorship. Your $900,000 purchase price would be allocated among the assets to produce the following adjusted basis for each asset:

The goodwill of $115,000 represents the difference between the $900,000 proposed purchase price and the total fair market value of each of the other assets.

If I can be of further assistance, please let me know.

Jeff Rose, CPA

Tax Partner

pp. 7-8, 7-9, and Example 13

8. a. Basis = $12,000; $8,000 (amount realized) - $12,000 (adjusted basis) = $4,000 (realized loss).

b. $0. The proceeds of $39,000 are between the gain basis of $45,000 and the loss basis of $30,000. Therefore, neither gain nor loss is recognized.

pp. 7-10 and 7-11

9. The issue is whether Holly will have a carryover basis of $2,500 for the stock inherited from Alice or a stepped-up basis (FMV at date of Alice's death) for the inherited stock. Section 1014(a) provides the general rule that the basis for inherited property is the fair market value of the property on the date of the decedent's death. However, § 1014(e) provides an exception to this FMV basis (the so-called deathbed gift rule). Under this provision, if appreciated property is inherited by a taxpayer (or the taxpayer's spouse) and the property was acquired by the decedent by gift from that taxpayer, a carryover basis may be required. Such a carryover basis is required if the time period between the date of the gift and the date of the donee's death is not greater than one year.

10. a. $5,000 ($7,000 cost - $2,000 accumulated depreciation).

b. $2,500 ($5,000 basis/2 years).

c. Loss basis = $3,500 (fair market value) - $2,500 (depreciation allowed) = $1,000; $800 (selling price) - $1,000 (adjusted basis) = $200 (realized loss).

d. Gain basis = $5,000 (Beth's original basis) - $2,500 (depreciation for one year) = $2,500. $4,000 (selling price) - $2,500 (adjusted basis) = $1,500 (realized gain).

pp. 7-10, 7-11, and 7-13

11. a.

Since the gift is made before 1977, all of the gift tax paid is added to the donor's adjusted basis. The fair market value ceiling of $100,000 does not apply because it is in excess of the resulting summation of $52,000.

p. 7-12

12. Either Simon or Fred should receive the benefit of deducting the realized loss on the sale of the stock. On the surface, it appears that Simon should give the stock to Fred and let Fred sell it, since Fred is in the higher tax bracket (i.e., 28% versus Simon's 15%). However, a taxpayer cannot deduct another taxpayer's loss. For gift property, this is achieved by the loss basis to the donee being the lower of (1) the donor's adjusted basis or (2) the fair market value on the date of the gift. Therefore, Simon should sell the stock, deduct the realized loss, and give the sales proceeds to Fred since the stock has declined in value (i.e., adjusted basis is greater than the fair market value at the date of the gift). pp. 7-10 and 7-11

13. Liz has generated zero recognized gain or loss, since the amount realized ($54,000) falls between the basis for gain ($70,000) and the basis for loss ($50,000). In this case, the gift tax paid does not affect basis. Example 20 and p. 7-12

14. a. No, the executor cannot elect the alternate valuation date. In order to be permitted to do so, the following requirements must be satisfied:

• The election results in the reduction of the value of the gross estate.
• The election results in the reduction of the estate tax liability.

p. 7-14

15. a. If the primary valuation date and amount apply, Robert's basis for the assets would be the fair market value at the date of Earl's death.

b. The election of the alternate valuation date by the executor would produce the following basis for each asset distributed to Robert.

Since the stock was distributed prior to the alternate valuation date, Robert's basis for it would be the fair market value on the date of its distribution to him.

pp. 7-13 and 7-14

16. a. Sale by Sheila

Sale by Jacob

Since Sheila and Elane are related parties, the realized loss of $10,000 is disallowed by § 267.

Sale by Jacob

Jacob is not eligible to use any of Sheila's disallowed loss of $10,000 under the right of offset since he is not the original transferee (i.e., Elane is the original transferee).

p. 7-15

17. a.

Peony's adjusted basis for the shares purchased on January 10, 1999 is the cost of $80,000.

Two-thirds of the stock sold is subject to the wash sale rules, since Peony purchased 100 shares of Lavender, Inc. stock within 30 days of the sale date. Therefore, two-thirds of the realized loss of $15,000 is disallowed and one-third is recognized.

Peony's basis for the stock purchased on January 10, 1999 is calculated as follows:

c. The wash sale provision will prevent Peony from recognizing $10,000 of the realized loss of $15,000 ($75,000 amount realized - $90,000 adjusted basis). Peony can avoid the wash sale provision by not acquiring substantially identical stock within 30 days before or after the date of the sale. Therefore, it should not purchase shares of stock in Lavender within this time period. It could purchase Lavender stock outside this 60-day window or purchase the stock of another corporation.

pp. 7-15 and 7-16

The realized loss on the personal use portion is not recognized.

*$11,370 = 14,000 basis at conversion - $2,630 cost recovery.

The $10,500 personal use residence gain may be excluded under sec. 121.

pp 7-16 to 7-18

19. a. Surendra's basis for loss is $150,000, the lower of the adjusted basis of $180,000 or the fair market value at the date of the conversion of $150,000.

b. Surendra's basis for depreciation is $150,000, the same as the basis for loss.

c. Surendra's basis for gain is the adjusted basis of $180,000.

pp. 7-16 and 7-17

The exchange qualifies for § 1031 postponement treatment. pp. 7-21 to 7-24

b. Because of the postponed gain, the basis in the land is $110,000 ($215,000 - $105,000). p. 7-25

21. a. October 7, 1998

The transaction qualifies as a like-kind exchange. Tex's basis for the land received is $175,000 ($250,000 - $75,000).

The sale of the land by Tex results in the realized gain of $75,000 previously postponed being recognized.

The transaction qualifies as a like-kind exchange. Tex's basis for the land received is $175,000 ($250,000 - $75,000).

February 15, 1999

Only Paige is involved in the sales transaction on February 15, 1999. However, since Tex and Paige are related parties, neither party must dispose of the like-kind property received for two years. Since Paige sold her land prior to the expiration of the two-year period, Tex's postponed gain of $75,000 on the October 7, 1998 exchange is recognized on February 15, 1999. As a result of this, Tex's adjusted basis for his land is increased to $250,000 ($175,000 adjusted basis + $75,000 recognized gain).

c. Willis, Davis, Raabe, Kaplan, and Engle, CPAs

50 Kellogg Boulevard

St. Paul, Minnesota 55164

November 1, 1998

Mr. Tex Wall

The Corral

El Paso, TX 79968

Dear Mr. Wall:

You have asked me to provide you with the tax consequences of the October 7, 1998 land exchange with your daughter, Paige. Based on the data you provided, the tax consequences to you are as follows:

Since the transaction qualifies for nontaxable exchange treatment as the exchange of like-kind property, your potential gain of $75,000 is postponed. The adjusted basis for the land you received is $175,000 ($250,000 fair market value - $75,000 postponed gain).

Section 1031 of the Internal Revenue Code provides for the aforementioned treatment. However, since the exchange was with a related party (i.e., Paige), the Code provides that neither you nor Paige should dispose of the land you received in the exchange prior to two years after the date of the exchange (i.e., October 8, 2000). Such a disposition by either of you would make the exchange transaction on October 7, 1998 taxable for both Paige and you as of the date of the disposition. I suggest that you communicate this information to Paige.

If I can be of further assistance, please let me know.

Sincerely,

Margaret Ryan, CPA

Tax Partner

pp. 7-23 and 7-26

The personal computer and the laser printer are depreciable tangible personal property which are in the same general business asset class. Therefore, the exchange qualifies as the exchange of like-kind property. pp. 7-22 to 7-24

b. Because the realized gain of $4,000 is postponed, Snipe's basis for the printer is $12,000 ($16,000 fair market value - $4,000 postponed gain). pp. 7-25 to 7-26

23. a. and b.

The exchange qualifies for like-kind exchange treatment. However, since boot (i.e., the stock) is received, the realized gain is recognized to the extent of the boot received. Since the boot received of $100,000 is less than the realized gain of $150,000, only $100,000 of the $150,000 realized gain is recognized.

c. Since only part of the realized gain is recognized, the basis of the land is $125,000 (fair market value of $175,000 - postponed gain of $50,000). The basis of the stock is the fair market value of $100,000.

pp. 7-22 to 7-26

24. The critical question is whether the transactions qualify for § 1031 deferral treatment. Ross Industries' preference probably is to have the gain on the land deferred and the loss on the stock recognized. Therefore, the key is to be aware of whether the land and the stock to be received qualify as like-kind property. Since only the land qualifies, Ross can exchange the land (i.e., defer the realized gain) and either sell or exchange the stock (i.e., recognize the realized loss). pp. 7-22 and 7-23

25. a. Because the postponed gain is $50,000, the basis equals $150,000 ($200,000 - $50,000).

b. Because the postponed gain is $320,000, the basis equals $30,000 ($350,000 - $320,000).

c. The transaction does not qualify as a like-kind exchange. Therefore, the basis of the newly acquired asset is equal to its fair market value, or $42,000.

d. The transaction does not qualify as a like-kind exchange. Therefore, the basis of the newly acquired asset is equal to its fair market value, or $18,000.

e. The transaction does not qualify as a like-kind exchange. Therefore, the basis of the personal use mountain cabin is equal to its fair market value, or $115,000.

pp. 7-22 to 7-24

26.

November 21, 1998

2501 Longview Lane

Marilyn Pierce, CPA

The second option typically would not be selected by Maroon. Although it results in a higher basis for Machine B ($21,000 rather than $15,000), Maroon has a recognized gain of $6,000. However, if Maroon had at least $6,000 of losses with which it could offset the recognized gain, the company would be motivated to select this option.

pp. 7-22 to 7-25

28. a. Realized gain = $25,000 [$30,000 (gain on like-kind property) - $5,000 (loss on property given up that is not like-kind)].

b. Recognized loss = $5,000 (on property given up that is not like-kind).

c. New basis = $25,000 [$55,000 (fair market value of new real estate) - $30,000 (postponed gain on the like-kind property)].

Example 39 and pp. 7-24 and 7-25

29. a. The exchange qualifies as a like-kind exchange.

The mortgage assumed by Indigo, Inc. is treated as boot received by Avocet Management Co. Therefore, Avocet's recognized gain is $80,000, the lower of the boot received of $90,000 or the realized gain of $80,000.

b.

c. The alternative would produce the following tax consequences:

Since the cash is treated as boot, the recognized gain of $80,000 would be the same as in (a). Avocet's adjusted basis for the office building and land of $410,000 would be the same as in (a). Therefore, the tax consequences to Avocet under the alternative proposal are the same as under the original proposal.

pp. 7-21 to 7-28

30. a. Realized gain = $9,000 [($12,000 fair market value of new asset + $4,000 boot received) - $7,000 adjusted basis of old asset].

Recognized gain = $4,000.

Postponed gain = $5,000.

New basis = $7,000 ($12,000 fair market value of new asset - $5,000 postponed gain).

b. Realized loss = $1,000.

Recognized loss = $-0-.

Postponed loss = $1,000.

c. Realized loss = $1,500.

Recognized loss = $-0-.

Postponed loss = $1,500.

New basis = $9,500 ($8,000 fair market value of new asset + $1,500 postponed loss).

d. Realized gain = $10,000.

Recognized gain = $-0-.

Postponed gain = $10,000.

New basis = $22,000 ($32,000 fair market value of new asset - $10,000 postponed gain).

e. Realized gain = $2,000.

Recognized gain = $1,000.

Postponed gain = $1,000.

New basis = $10,000 ($11,000 fair market value of new asset - $1,000 postponed gain).

f. Realized loss = $2,000.

Recognized loss = $-0-.

Postponed loss = $2,000

New basis = $10,000 ($8,000 fair market value of new asset + $2,000 postponed loss).

Example 42 and pp. 7-25 to 7-27

31. a.

b. Recognized gain = $375,000 [$125,000 (cash) + $250,000 (mortgage assumed by Dove, Inc. is treated as boot received); lower of boot received of $375,000 or realized gain of $400,000].

Postponed gain = $25,000.

c. New basis = $1,100,000 [$1,125,000 (fair market value of office building) - $25,000 (postponed gain)].

Example 43 and pp. 7-25 to 7-28

Since Cardinal Computing does not acquire qualifying replacement property, the realized gain of $125,000 is recognized.

Since the adjusted basis is greater than the amount of the insurance proceeds received, the realized loss on the involuntary conversion is recognized.

pp. 7-28 and 7-29

33. a. Since the taxpayer is an owner-investor, the taxpayer use test applies. Replacing the shopping mall with another shopping mall in a different location qualifies as replacement property.

b. Since the taxpayer is an owner-user, the functional use test applies. Replacing the warehouse used in its business with another warehouse in a different state which is to be used in its business qualifies as replacement property under the functional use test.

c. Since Swallow Fashions, Inc. was an owner-user of the building, the functional use test applies. Thus, Swallow's use of the replacement property and of the involuntarily converted property must be the same. Since its use of the four-unit apartment building is different from the use of the building in the retail business, the apartment building does not qualify as replacement property.

d. Since Susan and Rick are owner-users, the functional use test applies. The rental duplex does not qualify as replacement property under this test.

pp. 7-30 and 7-31

34. There are two issues that need to be addressed. The first is whether both Steve and Ross can qualify for deferral treatment under § 1033. The second is the manner in which Ross behaved in acquiring the property.

The resolution of the first issue for Ross is straightforward. As he is aware that the property is going to be condemned, he could qualify for deferral under § 1033(a)(2) even if he sold the property to someone other than the condemning authority. Since his intent is to sell to the condemning authority, he obviously qualifies. For Steve, the earliest date he can sell his property to Ross and qualify for deferral treatment is the date of the threat or imminence of requisition or condemnation of the property. Even though he does not appear to be aware of such a threat or imminence at the time of the sale to Ross, unless Ross informs him, it is unlikely the IRS would question his qualification for § 1033. However, he does not need to use § 1033. He can qualify for exclusion under § 121 since the house is his principal residence.

The manner in which Ross conducted his affairs initially raises serious questions. At the least, Ross has been less than truthful. While the property is being purchased by a corporation, Ross failed to disclose that he and his spouse own the corporation. In addition, Ross failed to disclose that the property is going to be subject to condemnation proceedings. Finally, Ross may be violating realtors' ethical standards which could result in sanctions.

35. a.

The transactions qualify for § 1033 involuntary conversion treatment. Lark reinvested part of the insurance proceeds received in qualifying property. Since not all of the insurance proceeds were reinvested, its recognized gain is calculated as follows:

Lark's basis for the replacement office building is $210,000 [$350,000 (cost) - $140,000 (postponed gain)].

None of the realized gain is postponed because Lark did not acquire qualifying replacement property.

pp. 7-29 to 7-32

Since the form of the involuntary conversion is a direct conversion (i.e., a warehouse for a warehouse), § 1033 nonrecognition is mandatory. Thus, none of the realized gain of $165,000 is recognized. Magenta's basis for the replacement warehouse is $325,000 ($490,000 fair market value - $165,000 postponed gain).

b. As indicated in part (a), since the form of the involuntary conversion is a direct conversion, § 1033 nonrecognition is mandatory. What Magenta should have done was not have accepted the surplus warehouse, but instead to have negotiated for cash. Then, it could have achieved its objective of recognizing gain by not electing § 1033 treatment.

p. 7-32

37. a. Postponed gain = $-0-. The $40,000 realized gain is recognized because the amount that the taxpayer reinvested is only $100,000. Basis = $100,000 - $0 = $100,000.

b. Postponed loss = $-0-. The casualty loss is recognized. Basis = $200,000 - $0 = $200,000.

c. Postponed gain = $50,000. Basis = $350,000 - $50,000 = $300,000.

d. Postponed loss = $-0-. The $2,000 casualty loss is recognized, less the $100 floor = $1,900. The $1,900 must be reduced further by 10% of adjusted gross income. This 10% floor is applied to the total of casualty losses that are deductible for the taxable year rather than to each casualty. Basis = $17,000 - $0 = $17,000.

e. Postponed gain = $80,000. Basis = $240,000 - $80,000 = $160,000.

f. Postponed gain = $1,000. Basis = $19,000 - $1,000 = $18,000.

g. Postponed loss = $-0-. The $2,000 loss on the condemnation of personal use property is nondeductible. Basis = $26,000 - $0 = $26,000.

h. Postponed gain = $50,000. Basis = $200,000 - $50,000 = $150,000.

pp. 7-29 to 7-33

38. Beverly's recognized gain on the sale of the 6,000 shares of Color, Inc. is $90,000. She may use the specific identification method to identify the shares sold.

Concord Instruments Corporation, 67 TCM 3036, T.C. Memo. 1994-248, in a similar fact pattern, concluded that the oral instructions to the broker to sell the stock with the highest cost basis constituted adequate identification of the shares.

Reg. § 1.107-1(c)(3) provides that stock is adequately identified if (1) the taxpayer specifies the particular stock to be sold at the time of the sale, and (2) the broker confirms in writing the taxpayer's instructions within a reasonable period of time. The IRS position, in Concord, was that the broker did not provide a written confirmation of the taxpayer's instructions as required by this regulation. Therefore, in determining the amount of the recognized gain, the FIFO basis must be used to determine the cost basis of the shares sold.

The taxpayer's response was to admit the regulation requirement was not satisfied, but to take the position that alternatives exist to the method prescribed in the regulations for identifying shares of stock sold.

The taxpayer's position was based on alternatives provided in case law which preceded Reg. § 1.107-1(c)(3).

The Tax Court accepted the taxpayer's argument. It concluded that the current regulations do not state that they provide the exclusive means for identifying the shares of stock sold. Instead, the regulations merely provide a safe harbor. Adequate identification can occur in other ways. Therefore, the Tax Court permitted the taxpayer to use the specific identification method.

Willis, Davis, Raabe, Kaplan, and Engle, CPAs

50 Kellogg Boulevard

St. Paul, Minnesota 55164

April 4, 1998

Mr. Albert Taxpayer

General Manager

Cleveland Indians

Jacobs Field

Cleveland, Ohio 44118

Dear Mr. Taxpayer:

I am responding to your request regarding the tax consequences of a proposed trade you are considering with the Seattle Mariners. According to our conversation, the two options under consideration are the following:

1. The Indians would receive Randy Johnson and $5 million from the Mariners in exchange for Marquis Grissom and David Justice.

2. The Indians would receive Randy Johnson and Edgar Martinez from the Mariners in exchange for Marquis Grissom and David Justice.

From a tax perspective, the second option is preferable because it qualifies for nontaxable exchange treatment under § 1031 of the Internal Revenue Code. The critical issue is whether major league baseball contracts qualify as like-kind property for purposes of § 1031. The IRS in Rev.Rul. 67-380, 1967-2 C.B. 291, provided that the trades of such contracts is considered exchanges of like-kind property.

Thus, if Grissom and Justice. are traded for Johnson and Martinez, any realized gain on the exchange is not recognized (i.e., it is postponed). However, if the initial proposal made by the Mariners of Johnson and cash is accepted, the cash of $5 million is treated as boot (i.e., not qualifying like-kind property) received. Assuming that the fair market value of the Johnson player contract and the $5 million exceed the Indians' adjusted basis for the Grissom and Justice player contracts, gain is recognized by the Indians to the extent of the lesser of the realized gain or the $5 million boot received.

As an aside, as a staunch Indians' fan, I strongly support the second option. If I can be of further service, let me know.

Sincerely,

Jerry Johnson, CPA

Partner

40. Tex can qualify for § 1033 involuntary conversion treatment associated with the sale of the 25 cows. Section 1033(e) provides that if livestock are sold on account of drought, the taxpayer can qualify for § 1033 postponement of gain treatment.

Reg. § 1.1033(e)(1)(a) provides that the livestock sales qualifying for this provision are only for sales in excess of the number the taxpayer would sell if he followed his normal business practices. Thus, the 25 cows sold by Tex solely on account of drought do qualify and the normal sales (10 cows) do not qualify.

Tex's realized gain on the sale of the 25 cows is calculated as follows:

In order to postpone the recognition of the realized gain, Tex must elect § 1033 treatment [§ 1033(a)(2)(A)]. In addition, he must use the net sales proceeds to purchase qualifying replacement property (i.e., dairy cows) within the statutory time period [§ 1033(a)(2)(B)(i)]. Thus, Tex has until December 31, 2000 to do so. To the extent the net sales proceeds are not reinvested by then, Tex's realized gain is recognized to the extent of the deficiency.

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